Q4 Earnings Beat at Quest Diagnostics

Quest Diagnostics’ (DGX) fourth-quarter 2013 adjusted earnings per share (EPS) from continuing operations of $1.03 surpassed the Zacks Consensus Estimate by 9.6% and the year-ago earnings by 2%. The adjusted EPS in the reported quarter excludes restructuring and integration charge of 6 cents compared to exclusion of 14 cents in the year-ago quarter for the same.

Full- year 2013 adjusted EPS from continuing operations came in at $4.00 although remained well ahead of the Zacks Consensus Estimate of $3.91, it declined 8.3% year over year.

Reported EPS in the fourth quarter was $0.97, reflecting an increase of 11.5% year over year. The 2013 reported EPS was $5.31, up 35.4% from the previous year.

Revenues from continuing operations for the fourth quarter of 2013 were down 1.0% year over year to $1.76 billion. However, revenues remained marginally ahead of the Zacks Consensus Estimate of $1.73 billion. Full-year revenues from continuing operations of $7.14 billion beat the Zacks Consensus Estimate by a whisker, but remained 3.2% below 2012 revenues.

Volume (measured by the number of requisitions) increased 2.3% year over year as recent acquisitions by the company added 3% to the volume.

Revenues per requisition were down 3% primarily due to reduced reimbursement (2% of the reduction). Moreover, the business mix impact of Quest Diagnostics’ recent toxicology acquisition contributed to the rest of the decline in revenues per requisition.

We believe that the overall soft industry trends leading to low volume growth were a dampener for the company. In addition, lower healthcare utilization and reimbursement cuts acted as other major deterrents. We expect this challenging scenario to adversely affect Quest Diagnostics’ peer Laboratory Corporation of America Holdings (LH) as well, which is scheduled to release its fourth-quarter 2013 results on Feb 7.

Among operating costs, cost of services during the reported quarter stood at $1.05 billion, down 2.05% year over year. Selling, general and administrative (SG&A) expenses edged down 1.4% to $415 million. The company did not incur any operating expenses in the ‘Other’ category compared to $4 million incurred in the year-ago quarter. Accordingly, adjusted operating margin in the quarter expanded 50 basis points (bps) to 16.5% on adjusted operating income of $290 million.

Quest Diagnostics exited 2013 with $187 million in cash and cash equivalents, down from $295.6 million at the end of 2012. Cash provided by operating activities for the year was $652 million compared with $1.18 billion a year ago. The company is focused on enhancing shareholder value and improving return on capital.

Quest Diagnostics recently made a 10% hike in quarterly dividend to 33 cents a share or $1.32 annually.

Outlook

Quest Diagnostics also posted it 2014 guidance. Amid a challenging volume environment, the company expects 2014 revenues to remain 2% below the 2013 level. The current Zacks Consensus Estimate of $7.12 remains ahead of the projection.

2014 EPS is expected to remain in the range of $3.90−$4.10. The Zacks Consensus Estimate of $4.20 remains way above the range.

Cash provided by operations outlook is $900 million and estimate for capital expenditure is $300 million.

Recent Activities

Quest Diagnostics has been focusing on areas with high potential such as gene-based esoteric testing for cancer, cardiovascular disease, infectious disease and neurological disorders. The company has experienced increasing demand for gene-based and esoteric tests compared to routine tests on account of increased esoteric mix contributed by Athena and Celera.

As part of this strategy, in Jan 2014, Quest Diagnostics announced a multi-year deal with Life Technologies Corp. (LIFE). Per the deal, Quest Diagnostics can use Life Technologies’ Ion Torrent, a next-generation sequencing (NGS) platform for the development of molecular tests.

Quest Diagnostics has also signed a similar agreement with Illumina Inc. (ILMN) whereby it will be allowed to use the latter’s MiSeq sequencing and genotyping technology platform and related reagents for molecular laboratory-developed tests. These deals are consistent with Quest Diagnostics’ aim of becoming a global leader in diagnostic and healthcare services. Quest Diagnostics has been working on strengthening its suite of diagnostic tests for quite some time now.

In 2013, Quest Diagnostics launched BRCAvantage to assess mutations in the BRCA1 and BRCA2 genes related to hereditary breast cancer. The company also offers advanced testing services for myelodysplastic syndromes. In a bid to enhance its diagnostics services, in January this year, Quest Diagnosticssigned a definitive agreement to acquire Solstas Lab Partners Group and its subsidiaries.

Recommendation

We remain cautious about Quest Diagnostics as it is continuously witnessing challenges with regard to testing volume and reimbursement cuts. Concerns also linger about the soft industry trends due to a decline in physician office visits, flat pricing and low organic revenues.